Importance of Keeping Your Personal and Business Finances Separate

Owning and running your own small business necessitates that you take on a dual role. You will obviously have your personal finances, but now you are adding an additional role of commercial business owner. Each role has its own needs and when it comes to finances it is crucial that you keep them separate no matter what size of type of business entity you create. IRS is very strict about making sure that you don’t intermingle your personal and business finances, including bank accounts, expenses, taxes and so on. Failure to do so can put you in hot water with IRS and lead to hefty penalty.  So how do you ensure the separation of personal and business finances?

The first important thing to know is that the money that your company makes is not the same as the money that you have made. If you are self-employed and work alone (as a carpenter or a landscape gardener for instance), it is still not the case that every cent you make you can just keep. The legal aspects of your business are still in force in this situation. You will need to keep a lot of what you’ve earned until the end of the fiscal year so that you can disclose it to the tax collection agency of your government. How much you will have to pay obviously depends on number of things, including whether you work alone and whether you are eligible for any tax deductions or write-offs. How much you have earned in a year will also determine what bracket you find yourself in. To stay on the safe side, you should only pay yourself the amount that you agree to in your contract. The rest should stay in the business. Besides, if you want to continue to grow your business, you will need as much of that money in your commercial accounts as possible. It is quite clear by now that it is paramount that you have to have separate accounts for your business compared to your personal accounts. This will demonstrate, if you are asked to prove it, that you were doing the right thing. If it is all in one account, you may find it more difficult to prove that all the purchases were for the business alone. If you have employees, there are specific taxes of which you should be aware because you may have to contribute money.

If you are looking for a house for sale and you are hoping to sell your own, it is not just a matter of finding a buyer, agreeing on a price and moving on. You need to be aware of the rules associated with these transactions. For instance, the IRS will allow you to exclude up to $250,000 of capital gains from your income. If you are filing jointly with a spouse, this goes up to $500,000. However, to qualify for the exclusion you need to have lived in the property and treated it as your home for at least two of the five years prior to the sale. Whether or not you are able to exclude some or all of the capital gain from the sale of a property, you need to declare it. If you fail to, you could invite legal scrutiny. Buying a home is similarly encumbered with legal jargon and a litany of forms to fill out. There are certain tax credits that you can claim if you are buying a place for the first time. In any case, all of these considerations should be subject only to your personal finances. Purchasing a house with money in your commercial accounts that is not for the business itself can once again get you in legal trouble. It is called embezzling. It may seem innocent enough since you made the money but maintaining the difference between the two types of accounts is your responsibility.

However, your taxes are not the only thing that you have to worry about. The possibility of being sued is quite real. In fact, a lot of cultures are becoming increasingly litigious. The case that is often cited in condemnation of this sort of practice is Liebeck vs. McDonald’s Restaurants. It is a famous case because if a person does not study it in depth, it can superficially seem as if the woman in question was simply careless and then tried to get millions of dollars in compensation. However, the details tell a different story. First, the coffee is question was kept at between 180 and 190 degrees Fahrenheit. As a point of comparison, a lot of other coffee outlets keep their drinks at 135 to 140 degrees Fahrenheit. The reason that McDonald’s gave for having so much hotter coffee was that it was better for the taste. However, it was also a great deal more dangerous, with the plaintiff, Stella Liebeck, suffering third-degree burns on 6% of her body. She was only suing McDonald’s initially for $20,000 so she could cover the costs of her medical treatments. The jury decided to award her $200,000 in compensatory damages which was later reduced to $160,000, as well as $2.7 million in punitive damages which was later reduced to $480,000 because Liebeck was deemed to be partly responsible for the accident. The case was widely reported in the media (and it continues to be). The case was further settled out of court by the two parties despite it having been decided in a public court.

You may not serve coffee to customers as your business but the fact is that any sort of accident can be a pretext for a lawsuit. McDonald’s are obviously a massive, and successful corporation and while they probably did not want to spend quite as much as they did on the incident (their legal fees are unknown and yet were probably substantial on their own) but they can afford to pay several million dollars (it is estimated that it is about two days worth of coffee sales). However, you may not be in the same situation. The difficult thing about a potential lawsuit is that it is not always just your business that is being sued. You could be personally liable too, or at least considered to be in legal terms. That is why it is so important to think about protecting yourself. Registering your company as an LLC (limited liability company) will not completely preclude the possibility of your personal assets becoming part of a potential settlement, but it is a good first step. Every business is different and will therefore represent a different vulnerability to lawsuits, which is why you should speak to a commercial lawyer in your area to find out more about what you can do to protect yourself.

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